In an unprecedented move, China’s State Council sent teams of officials to more than 10 of the financially weakest provinces to inspect their books and find ways to cut the over USD 13 trillion provincial debt that threatens the financial stability of the economy. Debt-laden local governments now represent a major risk to China’s economy.
Fears have grown over a public default on repayments of debt sold by local government financing vehicles (LGFVs). There are increasing worries over a potential debt defaults by LGFVs destabilising the financial sector. Guangfa Securities estimated that there were a total of 73 defaults in LGFVs sold in private transactions in the first quarter this year.
The fears over defaults by LGFVs increased after Zhongzhi Enterprise Group Co., that operates in China’s shadow banking linked trust fund market and having more than USD 138 billion under management, showed signs of becoming the latest Chinese financial giant to default. Affiliated firms of Zhongzhi, such as Zhongrong International Trust, a 36-year-old wealth management firm, has missed payments on some investment products, which has sent alarm bells across Chinese markets and investors.
The missed payments are adding to concerns over the health of China’s USD
2.9 trillion trust fund market that pool household savings to offer loans and invest in real estate, stocks, bonds, commodities. China is already struggling with a weak economy and fall out from the property market crisis is likely to see property market giants like Country Garden Holdings Co. defaulting.
The liquidity challenges of the trust funds indicate the deepening troubles in the Chinese property market and financial sector as many trust products are backed by real estate projects run by troubled developers such as China Evergrande Group and Country Garden Holdings Co. Evergrande has disclosed losses of USD 81 billion over 2021 and 2022, revealing the scale of the debt crisis. Country Garden estimated losses of USD 6.2-7.6 billion for the first half of this year.
The Covid 19 pandemic and collapse of land sales has sent the broader financial health of China’s regions spiraling downwards. According to S&P Global calculations, two-thirds of local governments have outstanding debt exceeding 120% of their income last year.
Tianjin, once one of China’s most developed industrial and manufacturing hubs, has a debt-to-GDP ratio of 138.3%. Guizhou, famed for the popular Mao-tai
brand of baijiu liquor, has debt-to-GDP ratio of 137.2% and Gansu, with lowest per-capita income among all regions, faces debt-to-GDP ratio of 123.4%.
According to a report by Moody’s Investors Service, some provinces like Jilin, Tianjin, Qinghai, Heilongjiang, Liaoning, Yunnan and Gansu suffered significant drops in revenue after land sales declined by more than half last year. Regions that have historically generated more income from LGFVs, such as Shandong and Fujian provinces, the falls have been much larger.
Concerns remain over how the local government trillion-dollar debt crisis can be solved at a time when China’s economic growth is slowing to unprecedented levels. According to the Rodium Group, questions remain whether the authorities would be ready to accept a significant slowdown in local government investment and spending on services in their quest to restructure the debt.
Already with increasing debt burdens and falling revenues local municipalities have cut spending, increasing prospects of social disturbance. Protests have broken out in recent weeks in cities such as Wuhan, Dalian and Guangzhou over cut in medical benefits and pensions due in part to strain government finances. Teachers in Shenzhen have complained about sharp cuts in bonuses.
In Zhengzhou, home to a Foxconn Technology Group assembly site for Apple Inc.’s iPhones, bus drivers say their salaries were cut in 2021 and have not been restored. Street sweepers say they have not been paid in months.
The unsustainable debt burden of the local governments also create risks for the fiscal health of the financial sector. According to Caida Securities, Chinese banks, which have roughly 30-40% of their assets invested in LGFV bonds, are likely to face growing pressure on asset quality and profitability from their exposure in the next 1-2 years. The growing negative sentiment among the businesses and consumers, as indicated by a sharp fall in new loans from Rmb 3 trillion in June to Rmb 345.9 billion in July, the lowest level since late 2009, would also undermine fiscal revenue, a major source for debt repayment.
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